One of the biggest challenges that retirees face is how to make their retirement savings last a lifetime. Even if one has saved diligently throughout one’s working life and accumulated a sizeable nest egg, it may not be able to generate enough to sustain monthly expenses over the long term. This is mainly due to three factors: longer life spans, early retirement and falling interest rates.
According to a report of the UN Population Fund, life expectancy at birth in India has risen from 60 years in 1994 to 69 years in 2019. That’s the average. Lifespans are longer in urban centres with medical facilities and among socio-economic classes that can access them. It is not uncommon to see people in their 80s and 90s, and things will only get better in future. As a result, the average upper middle-class urban retiree must have enough to last 20-25 years in retirement instead of 15-20 years earlier. At the same time, it is now common for people to leave full-time employment while in their early fifties. This means they have fewer years to accumulate their nest egg and more years to spend it.
All this is happening at a time when interest rates of fixed income options have come down and the investment landscape has changed drastically. Fixed deposits are offering senior citizens around 7% returns. The Senior Citizens’ Saving Scheme, the most lucrative option for retirees in the small savings stable, currently offers 8.6% but this could soon change.
Small savings rates are linked to government bond yields and are reset every three months. With the 10-year bond yield falling sharply to 6.5% in the past three months, the government is likely to cut the rates on small savings schemes in the next revision scheduled in October. Analysts say this will allow banks to cut their deposit rates. Banks want to bring down their cost of borrowing but can’t cut deposit rates due to competition from small savings.
This week’s cover story looks at the investment strategies followed by retirees to earn a monthly income in retirement. We have identified three options: the traditional approach that relies solely on fixed income options, a moderate approach that takes a little risk and the bucket strategy that financial planners suggest. Read on to know how the three strategies use a corpus of Rs 1 crore to generate monthly income in retirement.
Is Rs 1 crore enough?
On the face of it, a nest egg of Rs 1 crore appears big enough to sustain a retiree’s expenses for life. If put into an annuity plan when the individual is 60 years old, the corpus can yield a monthly pension of nearly Rs 70,000 for life. But this option will not give the principal back to the legal heirs of the investor on his death. If he wants his legal heirs to get back the principal amount of Rs 1 crore, he will have to settle for a lower income of around Rs 52,000 per month. That sounds good enough, right?
Wrong. A pension of Rs 52,000 might be sufficient today but won’t remain so forever. Inflation pushes up your expenses with each passing day. Even a moderate inflation rate of 6% per annum will take the monthly expense to Rs 90,000 a month in 10 years and to Rs 1.6 lakh in 20 years (see graphic). In other words, in 20 years, the pension from the annuity will be able to purchase barely a third of what it can purchase today. Somebody who has not factored in inflation in his retirement planning should get ready for a life of penury in his later years.
Keep inflation in mind when you plan your retirement
Even 6% rise in prices per year can sends the monthly expenses spiralling up.
The ultra-safe conservative retirement plan (see graphic) relies solely on income from annuity and fixed income options that give assured returns. While it is safe from the volatility of the bond market and the vagaries of the stock market, it will not be able to match the incessant march of inflation.
- ULTRA-SAFE CONSERVATIVE PLAN
Relies on annuity income and fixed income options that give assured returns
What’s good about this
- Investments are almost risk free and returns are assured.
- Income will not fluctuate due to interest rate changes or stock market volatility
What’s not so good
- Interest rates are not forever. If rates are lower when investments mature, they will be reinvested at prevailing rate to earn less.
- Inflation not taken into account. If investor needs Rs 50,000 a month in 2019, he will need around Rs 67,000 a month in 2024 and almost Rs 90,000 a month in 2029.
- These are pre-tax returns. Tax will further reduce the income.
What the investor can do
For the first six years, the investment will generate surplus income which can be reinvested. After the sixth year, investor can start liquidating some fixed deposits every month to bridge shortfall in income and expenses.
- MODERATE PLAN WITH SOME RISKS
Uses a mix of market-linked and fixed income options with a dash of equity
What’s good about this
- Returns not assured but risk is low. Mix of debt funds and fixed deposits cancel out the risks.
- Equity portion left untouched has potential to earn higher returns.
- Portfolio is more tax efficient than the ultra safe portfolio.
- Income can be customised by increasing the monthly withdrawal to account for inflation.
What’s not so good
- Interest income is fully taxable. Tax can eat into the returns.
- Element of risk in the equity portion as also debt funds. Must choose schemes carefully.
- Requires some basic knowledge of mutual funds and how they function.
What the investor can do
After a few years, investor can gradually start shifting the equity portion to the safety of debt.
What retirees can do
Mutual fund houses, stock analysts and financial planners don’t tire of telling us that equities have the potential to give the highest returns among all asset classes. But as we have seen in the past few months, equities bought at the wrong time and at the wrong price also have the potential to churn out the biggest losses. For a retiree who depends solely from income from his investments, even a small loss can be quite disconcerting.
Even so, retirees do need a dash of equities in their portfolios to help them stay ahead of inflation. They also need to invest in market linked instruments that are more tax efficient than fixed deposits and small savings schemes. Pension income and interest from bank deposits is fully taxable. Senior citizens enjoy a Rs 50,000 exemption on interest income but anything beyond that is taxed at the normal rates.
The Moderate portfolio uses debt funds to earn tax efficient returns. Gains from debt funds are taxed at a lower rate of 20% with indexation benefit if held for more than three years. Since withdrawals are mix of the principal and the gain, the effective tax on the withdrawn amount is very low. The Moderate portfolio has also allocated 10% to equity funds to generate higher returns. But while this corpus can last longer than the pure debt-based traditional portfolio, it may not sustain for 25 years.
The three-bucket approach
Splits the corpus into three portions for the short, medium and long term.
|Instrument||Returns offered (%)||Amount invested||Monthly income|
|Like the others, this also uses annuity and fixed income options||8||Rs 50 lakh||Rs 33,500|
The balance Rs 50 lakh is put into three buckets.
BUCKET I: For first five years
BUCKET II: Years 6 to 12
BUCKET III: Years 13 to 18
The bucket strategy helps segregate long term investments from the money meant for immediate use. However, the investor needs to be fully committed to follow this approach. If he panics when stock markets tumble and withdraws his equity funds, the whole purpose of the strategy will be defeated.
A more sophisticated strategy is to split the corpus into three buckets. The first bucket is for immediate use and relies on a liquid fund. The second bucket is for the medium term (6-12 years) and uses equity-oriented hybrid funds. The money in the third bucket is for the long term (over 12 years) and gets invested in equity funds.
Experts say the bucket strategy helps segregate long-term investments from the money meant for immediate use. However, the investor needs to be fully committed to follow this approach. If he panics when stock markets tumble and his equity funds decline, the whole purpose of the strategy will be defeated.